Cryptocurrencies were the investment story for this year with gains handily beating the S&P 500.

The cryptocurrency sector has often been avoided by investors and seen as a retail investor’s world.

However, that seems to be changing with the listings of financial companies such as Coinbase and Robinhood, which give brokerage services to those looking to purchase cryptocurrencies.

The two companies have aided cryptocurrency in reaching the mainstream, but the risks are rising for both of these companies. Even the top cryptocurrencies are struggling to prove any real-world utility, and lawmakers are working to crack down on the sector.

Why I won’t buy Coinbase

Coinbase tried to launch its Lend platform, which was created to allow its customers to get interest on their crypto holdings, but the SEC stopped this move, citing issues with how the product is classified.

The company produced revenue in the first half of this year that was over 10 times more than what it produced last year. However, that performance is not likely to be copied in the future. Because during that time, the market had a surge in the value of most cryptos, taking the overall value of all tokens from $780 billion at the opening of 2021 to more than $2.5 trillion only five months after. Prices have since gone down and failed to reclaim these highs.

Coinbase’s whole business model depends on customers trading tokens, as the firm earns transaction revenue as they do. These fees make up more than 95% of their top line. When cryptos are placid, Coinbase makes less fees, and many investors are now skeptical about the increased market activity lasting into 2022. While analysts predict Coinbase will deliver $6.88 billion in revenue for 2021 (up from $1.28 billion last year), they also believe it will lower to $6.20 billion next year with EPS going down more than 50%.

For this reason, Coinbase seems to me to be a short-term play as opposed to a good company with long-term growth.

Why I won’t buy Robinhhood

Robinhood has also faced government scrutiny as its “gamified” app was found to encourage risky investing among its young users. To make issues worse, the firm made a large pivot this year to focus on crypto markets to satisfy its younger audience, at this same time the SEC was scrutinizing the industry as a whole.

While cryptos make up only 22% of Robinhood’s users’ assets, they now make up over 52% of its overall transaction revenue. That suggests Robinhood’s user base is trading cryptos with more frequency than stocks, and they are forking over higher fees for these transactions. Essentially, Robinhood’s move to cryptocurrency markets could further enhance its customers’ appetite for more risk.

In Q2, over 62% of Robinhood’s $233 million in crypto transaction revenue was from Dogecoin, a meme coin often supported by social media — which certainly does not represent smart investing.

Aside from these issues drawing new attention to Robinhood from the government, there is also the fact that tokens such as Dogecoin probably won’t have staying power long-term. Only 1,700 businesses worldwide accept the coin as a payment method, and that figure is growing at a rate of just 50 businesses per month. It is unlikely Robinhood can create a long-term business from what is ultimately a speculation vehicle.

To end Robinhood’s regulatory problems, it’s coming off a $65 million SEC fine for misleading its users about how it generates revenue. Despite the platform having zero commissions, the regulator discovered its users were charged hidden fees through its payment-for-order-flow model that more than outweighed the trading commissions savings.

Author: Scott Dowdy

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